the dividend controversy principles of corporate finance brealey and myers sixth edition slides by...
TRANSCRIPT
The Dividend Controversy
Principles of Corporate FinanceBrealey and Myers Sixth Edition
Slides by
Matthew Will Chapter 16
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
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Topics Covered
How Dividends Are Paid How Do Companies Decide on Dividend
Payments? Information in Dividends and Stock
Repurchases Dividend Policy is Irrelevant The Rightists Taxes and the Radical Left The Middle of the Roaders
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Types of Dividends
Cash Div Regular Cash Div Special Cash Div Stock Div Stock Repurchase (3 methods)
1. Buy shares on the market
2. Tender Offer to Shareholders
3. Private Negotiation (Green Mail)
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Dividend Payments
Cash Dividend - Payment of cash by the firm to its shareholders.
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Dividend Payments
Cash Dividend - Payment of cash by the firm to its shareholders.
Ex-Dividend Date - Date that determines whether a stockholder is entitled to a dividend payment; anyone holding stock before this date is entitled to a dividend.
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Dividend Payments
Cash Dividend - Payment of cash by the firm to its shareholders.
Ex-Dividend Date - Date that determines whether a stockholder is entitled to a dividend payment; anyone holding stock before this date is entitled to a dividend.
Record Date - Person who owns stock on this date received the dividend.
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Dividend Payments
Stock Dividend - Distribution of additional shares to a firm’s stockholders.
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Dividend Payments
Stock Dividend - Distribution of additional shares to a firm’s stockholders.
Stock Splits - Issue of additional shares to firm’s stockholders.
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Dividend Payments
Stock Dividend - Distribution of additional shares to a firm’s stockholders.
Stock Repurchase - Firm buys back stock from its shareholders.
Stock Splits - Issue of additional shares to firm’s stockholders.
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Stock Repurchases
0
20
40
60
80
100
120
140
1985 1987 1989 1991 1993 1995 1997
$ B
illi
ons
U.S. Stock Repurchases 1985-1997
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Dividend Payments
Aug 14 Aug 25 Aug26 Sept 1 Sept 15
Declaration With- Ex-dividend Record Paymentdate dividend date date date
date
Share price falls
Maytag’s Quarterly Dividend
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The Dividend Decision
1. Firms have longer term target dividend payout ratios.
2. Managers focus more on dividend changes than on absolute levels.
3. Dividends changes follow shifts in long-run, sustainable levels of earnings rather than short-run changes in earnings.
4. Managers are reluctant to make dividend changes that might have to be reversed.
Lintner’s “Stylized Facts”
(How Dividends are Determined)
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The Dividend Decision
Attitudes concerning dividend targets vary
Dividend Change
1
1
EPS ratiotarget
dividendtarget DIV
1
1
EPS ratiotarget
dividendtarget DIV
01
01
DIV-EPS ratiotarget
changetarget DIV-DIV
01
01
DIV-EPS ratiotarget
changetarget DIV-DIV
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The Dividend Decision
Dividend changes confirm the following:
01
01
DIV-EPS ratiotarget rate adjustment
changetarget rate adjustmentDIV-DIV
01
01
DIV-EPS ratiotarget rate adjustment
changetarget rate adjustmentDIV-DIV
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Dividend Policy
-15
-10
-5
0
5
10
15
Div RiseDiv Cut
Source: Healy & Palepu (1988)
Ch
ange
EP
S/P
rice
at
t =
0 a
s %
Year
Impact of Dividend Changes on EPS
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Dividend Policy is Irrelevant
Since investors do not need dividends to convert shares to cash they will not pay higher prices for firms with higher dividend payouts. In other words, dividend policy will have no impact on the value of the firm.
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Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares
a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.
Record Date
Cash 1,000
Asset Value 9,000
Total Value 10,000 +
New Proj NPV 2,000
# of Shares 1,000
price/share $12
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Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares a
$1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.
Record Date Pmt Date
Cash 1,000 0
Asset Value 9,000 9,000
Total Value 10,000 + 9,000
New Proj NPV 2,000 2,000
# of Shares 1,000 1,000
price/share $12 $11
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Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares a
$1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.
Record Date Pmt Date Post Pmt
Cash 1,000 0 1,000 (910sh @ $11)
Asset Value 9,000 9,000 9,000
Total Value 10,000 + 9,000 10,000
New Proj NPV 2,000 2,000 2,000
# of Shares 1,000 1,000 1,091
price/share $12 $11 $11
NEW SHARES ARE ISSUED
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Dividend Policy is Irrelevant
Example - continued - Shareholder Value
Record
Stock 12,000
Cash 0
Total Value 12,000
Stock = 1,000 sh @ $12 = 12,000
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Dividend Policy is Irrelevant
Example - continued - Shareholder Value
Record Pmt
Stock 12,000 11,000
Cash 0 1,000
Total Value 12,000 12,000
Stock = 1,000sh @ $11 = 11,000
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Dividend Policy is Irrelevant
Example - continued - Shareholder Value
Record Pmt Post
Stock 12,000 11,000 12,000
Cash 0 1,000 0
Total Value 12,000 12,000 12,000
Stock = 1,091sh @ $115 = 12,000
Assume stockholders purchase the new issue with the cash dividend proceeds.
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Dividends Increase Value
Market Imperfections and Clientele Effect
There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from.
These clients increase the price of the stock through their demand for a dividend paying stock.
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Dividends Increase Value
Dividends as Signals
Dividend increases send good news about cash flows and earnings. Dividend cuts send bad news.
Because a high dividend payout policy will be costly to firms that do not have the cash flow to support it, dividend increases signal a company’s good fortune and its manager’s confidence in future cash flows.
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Dividends Decrease Value
Tax Consequences
Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably.
In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.
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Taxes and Dividend Policy
Since capital gains are taxed at a lower rate than dividend income, companies should pay the lowest dividend possible.
Dividend policy should adjust to changes in the tax code.
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Taxes and Dividend Policy
0.101000.10100(%) return of rateAfter tax
66.9)17.15()83.510(1050.2)50.120(taxes)-gain cap(div
incomeTax After Total17.183.5.202.5012.50.2020% @ Gain Cap onTax
00.510.50050% @ div onTax
4.161005.12100(%) return of ratePretax
5.8312.50gain Capital
96.67100pricestock sToday'
112.50112.50payoffpretax Total
100Dividend
102.50112.50price sNext year'dividend) (high
BFirm
dividend) (no
A Firm
96.679.66
10010
96.6715.83
10012.5
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Taxes and Dividend Policy
1998 Marginal Income Tax Brackets
Income Bracket
Marginal Tax Rate Single Married (joint return)
15% $0 - $25,350 $0 - $42,35028 25,351 - 61,400 42,351 - 102,30031 61,401 - 128,100 102,301 - 155,95036 128,101 - 278,450 155,951 - 278,450
39.6 over 278,450 over 278,450
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Taxes and Dividend Policy
Rate of Income tax
0% 39.60%Operating Income 100 100Corporate tax (Tc=.35) 35 35After Tax income (paid as div) 65 65Income tax 0 25.7Cash to Shareholder 65 39.3
In U.S., shareholders are taxed twice (figures in dollars)
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Taxes and Dividend Policy
Rate of Income tax
15% 33% 47%Operating Income 100 100 100Corporate tax (Tc=.33) 35 33 33After Tax income 67 67 67
Grossed up Dividend 100 100 100Income tax 15 33 47Tax credit for Corp Pmt -33 -33 -33Tax due from shareholder -18 0 14Cash to Shareholder 85 67 53
Under imputed tax systems, such as that in Australia, shareholders receive a tax credit for the corporate tax the firm pays (figures in Australian dollars)